The recent market selloff with its multiple linked triggers (inflation, fiscal expansion, past FX adjustment) and amplifiers (program trading, volatility funds and instruments, pricey valuations and desire to take profits in tax-mitigating way), seems a good time to take stock of the drivers of the macro and market environment going forward, to update you all on some of the themes/topics/opportunities I’m tracking in 2018 and beyond. The themes and framework are described in this pdf in more detail.
Many of these are longstanding topics that have driven macro and market sentiment in recent years (trade policy, fiscal stance), some may be well choreographed (CB balance sheet adjustment, energy rebalancing), even if likely to be over-estimated as exits approach. Others warrant some additional consideration in a global context (infrastructure development and finance).
I touched on many of these in my 2018 look-ahead in November, and will be updating my views as the months go on. This framework may help me and others identify how the different themes interact. No doubt, new topics will emerge or some of these topics interact.
Bottom line: Macro environment in 2018 still looks set to be relatively benign, with a pickup in global growth, and greater synchronicity of major economies (as laggards begin to catch up). Looking ahead, policy uncertainty (around trade and FX policy) suggest challenges for business planning, and greater costs to consumers, contributing to a slowdown in global growth in 2019-20, suggesting profits should follow suit. Coupled with higher rates and greater competition for capital, debt servicing issues should come more into the fray as the end of expansionary monetary policy facilitates a closer look at sovereign and corporate fundamentals. County selection matters. Price pressures are still likely to be manageable, but greater issuance of debt and equity suggests profit outlook matters. In several EM/Frontiers expect government dominated or secured investment to retain its key place.
I’ll talk more about risk scenarios in the days to come. I look forward to hearing about what I missed, what your signposts are and what scenarios you’re preparing for.
This post shares a few takeaways from my discussions last week in London with policymakers, investors and analysts on MENA and energy. Overall, sentiment was upbeat.There were two big elephants in the room: Saudi Arabia economic and foreign policy activism and the Iran nuclear deal. There remains significant uncertainty around the implementation around those issues, which offsets what is generally a more upbeat outlook in the face of $65-70/barrel crude.
One broader question pervaded my discussions. How much do higher oil prices help? Brent around $70 (or even in the mid 60s) gives significant more room for maneuver and likely will reinforce government driven growth across the GCC as it likely implies less fiscal austerity. It clearly buys time and room for maneuver and spread compression. However, we see only Kuwait and possibly the UAE having scope to resume saving, meaning that regional sovereign funds are likely to receive little new capital as more of the funds are used to support domestic spending. These trends will reinforce the ongoing acceleration of local growth from the 2016-17 pace, much private sector is likely to drag behind as the desire for quick growth brings government actors more into play.
Institutional investors remain constructive on GCC bonds on valuation grounds especially vs Asian alternates and even some of the more liquid CEEMEA names in the USD space. Oman and Egypt seemed to be top picks given that macro environment seemed to be better than feared, allowing some yield compression. $70 brent provides a lot of space for regional external balances and pegs, even if it won’t help fiscal balances much. Expect the GCC to continue to dominate global USD issuance among EM and Frontiers again in 2018, with Qatar joining peers. Going forward, concern may rise about Bahrain, and whether any regional support may not help bond investors.
Oil price and fundamentals: there’s a general consensus that the market is rebalancing and the OPEC + (Vienna agreement) has “worked” and the excess inventories in the U.S. will continue to be drawn down this year, but there is less consensus about the price forecast, which has a wide band around 55-80 this year. This reflects a difference of opinion about the growth in global demand (between 1.1 and 1.7mbd) and the persistence of the production freeze if prices remain high and incentive to cheat rises. On the demand side a key question is whether rising costs will dampen consumption growth (MENA oil producers are one place to watch, as is U.S. and Asian consumers) while shale production is a key place to watch on the supply side.
Global oil majors and many in GCC seem to be looking for $65 Brent this year, seeing some increase in shale output, some drawdown in inventories and the risk of a speculative correction. Others especially on the sellside seem to be sharply scaling up their forecasts, with Goldman Sachs pointing to the possibility of $85 by mid-year. In this price environment, expect oil companies revenues to move up but new investment is unlikely to outstrip plans.
Saudi Policy consternation: The Saudi anti-corruption detentions seem to be coming to an end, with reports that $100 billion in assets have been raised, likely a combination of stakes in companies and cash. This turns attention to the many key questions about the new anti-corruption regime, new institutions and the broader economic reform. Will Saudi authorities continue to hike public wages, even if that places a greater burden on the public sector? What will the new legal process be for corruption cases? Where will the new funds be managed? Will these funds be incorporated into the Public Investment Fund (PIF) which is already managing much domestic investment funds and waiting for new foreign issuance. Interest in the Aramco IPO seemed to have died down despite the improved oil valuation with many investors waiting to believe when they see terms. Meanwhile, the general view was that economic growth would accelerate and
The PIF itself is a matter of much interest, with many investors and regional watchers wondering how its asset allocation will evolve, how it will balance the foreign versus domestic investments and how it will balance competing mandates. It is rapidly staffing up and cares about a professional structure, but like many areas of Saudi policy, it is being asked to do a lot at once, with mixed goals.
Iran deal and economic policy: Coming only a few weeks after President Trump’s ultimatum on the nuclear deal and demand that European allies improve the deal, there was a lot of uncertainty on investment outlook. The view from Europe (especially France and Italy) is that the deal is working, and the burden high for changes, and the Iranians seem to be woking had to make sure that they are not blamed for the deal falling apart. This suggests major changes might be a hard task. Some European countries have already chosen to backstop local companies doing business in Iran, though oil companies concede that Iranian domestic policy uncertainty and term preferences pose as much concern as U.S. sanctions. Banks remain very concerned about sanctions and regulatory risk, which may explain the direct support of European firms. Meanwhile local macro issues including the vulnerabilities of the non-bank credit and the battle between government and IRGC suggest that Iran may struggle to benefit from some of the higher energy prices. The recent protests have triggered a less restrictive fiscal policy, with more subsidies remaining in place, and greater domestic leverage from the government.
Qatar: The general view is that the blockade is here to stay for some time and I've written extensively about Qatari resilience to the blockade due to its deployment of past savings. The economy has bounced back, the continued energy trade has provided solace to investors, and support from the U.S. and EU has limited the approach to secondary sanctions by the Saudis/Emiratis. Indeed, the new supply chains with Iran and Turkey look likely to stay. The recent U.S.-Qatar meeting likely increases Qatari leverage. Still, there are losers at home and the public sector is driving economic activity and absorbing more of the loans. These trends are likely to continue, as local rates remain high. The broader costs to GCC coordination and institutional strength are significant. Regional competition is likely to outstrip coordination resulting in lower domestic liquidity.
Finally, natural gas: If anything there was an even wider divide on natural gas fundamentals and price, with energy market representatives differing on whether there is an LNG supply glut, whether new entrants are taking advantage of cheap supplies sufficiently, and whether new supplies will offset. Policy mandates from China and other growing demand suggest that supply may be absorbed, and the market is gradually becoming less regional. I did field a lot of questions about U.S. energy policy and in particular support/demand for coal, which had some gas producers concerned. The pressure on higher cost natural gas producers is likely to remain.
Rachel's musings on macroeconomic issues, policy and more.